Red Sur Background documents Series Natural Resources and Development Report WORKING DOCUMENT N 4 Extractive industries as a platform for

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1 Red Sur Background documents Series Natural Resources and Development Report WORKING DOCUMENT N 4 Extractive industries as a platform for the creation of knowledge intensive industries: Trinidad and Tobago s oil and gas service providers Preeya S. Mohan Eric Strobl Patrick Watson 1

2 Red Sur Background documents Series Natural Resources and Development Report > Edition WORKING PAPER N 4 > Extractive industries as a platform for the creation of knowledge intensive industries: Trinidad and Tobago s oil and gas service providers Red Sudamericana de Economía Aplicada/Red Sur Luis Piera 1992, Piso 3 - Edificio Mercosur, CP 11200, Montevideo, Uruguay Website: December 2016 Executive Direction: Cecilia Alemany and Andrés López Production: Victoria Agosto and Carolina Quintana Edition: Natalia Uval Design/compilation: Diego García All rights reserved. The total or partial reproduction of this work by any means (either graphic, electronic, optical, chemical, mechanical, photocopying, etc.), or its storage or transmission in any form (magnetic, audio, video or any other media) are not allowed without prior consent from Red Sur. To obtain written permission to perform any form of reproduction or to proceed with the translation of this publication, please contact the Coordination Office via at coordinacion@redmercosur.org The publication of this work was made possible through the support of the International Development Research Centre (IDRC of Canada), within the project Small and Medium Enterprises, Job Creation, and Sustainability: Maximizing Opportunities from South America s Commodities Boom and the initiative The Future of Extractive Industries in Latin America and the Caribbean and the Role of Science, Technology and Innovation (STI). The publication of this work was also possible thanks to the support of the United Nations Perez Guerrero Trust Fund (PGTF/G77). 2

3 The South American Network on Applied Economics (Red Sudamericana de Economía Aplicada, Red Sur), is a policy-oriented research network integrated by public and private universities and centers of knowledge production in the region. It conducts research in the areas of economic development, natural resources, inclusive growth, employment, integration, trade and value chains, productivity and innovation. Red Sur is interested in promoting regional socio-economic analysis for policy discussion to respond to the challenges of development. It promotes, coordinates and develops joint studies from an independent and rigorous perspective on the basis of common methodologies with a regional vision. Red Sur has had the support of the International Development Research Centre (IDRC, Canada) since its inception. The reliance on oil and gas has long been Trinidad and Tobago s strength and weakness. The country is rich in oil and gas resources and considered the most industrialized economy in the English-speaking Caribbean. Its first-class oil and gas and downstream petrochemical industry is over 100 years old, with a growing number of oil and gas Knowledge Intensive Business Services (KIBS) firms operating regionally and internationally. The oil and gas services sector where KIBS firms operate employs about one third of all oil and gas sector workers, and globally the share of knowledge intensive services to total output has been steadily increasing over time. Yet, the challenges and opportunities for the future are many, not to name the drastic fall in international oil and gas prices along with falling oil and gas production locally. While the government invested in education and training and the country has a highly educated workforce, the country has been less successful at diversification and entrepreneurship. In transitioning from an extractive to a knowledge based economy Trinidad and Tobago s public policies now need to focus on science, technology and innovation and on creating and diffusing knowledge. While the T&T government has stated its intention to diversify the economy and increase innovation there has been little success. Trinidad and Tobago s oil and gas KIBS firms may play a major role here and for the analysis of the future of extractive industries in Latin America and the Caribbean. KIBS firms are likely to be one of the main engines for future growth. The objective of this study is to empirically examine the role of Trinidad and Tobago oil and gas KIBS firms in diversifying the economy away from an extractive to a knowledge intensive sector. The paper also examines the role of oil and gas KIBS firms in building employment capabilities, human capital development, environmental protection and sustainability given their importance in knowledge-based economies. The paper uses primary and secondary data sources and firm specific case studies. The case of TOFCO for instance, illustrates diversification into new subsectors within the oil and gas services sector, as well as new sectors outside of oil and gas services. The paper identifies opportunities for cooperation, knowledge sharing and experiences from Trinidad and Tobago that can be replicated in the region. The paper concludes by making policy recommendations, identifying opportunities and obstacles for their implementation and possible institutional implications to further develop the sector by using examples of successful policies and strategies in other countries. 3

4 The South American Network on Applied Economics / Red Sur is an academic network with the following members > ARGENTINA CEDES: Center for the Study of State and Society/Centro de Estudios de Estado y Sociedad. CENIT: Research Centre for Transformation/Centro de Investigaciones para la Transformación. IIEP-BAIRES: Instituto Interdisciplinario de Economía Política. ITDT: Torcuato Di Tella Institute/Instituto Torcuato Di Tella. UDESA: University of San Andrés/Universidad de San Andrés. BRAZIL IE-UNICAMP: Institute of Economics, State University of Campinas/Instituto de Economia, Universidade Estadual de Campinas. IE-UFRJ: Institute of Economics, Federal University of Rio de Janeiro/Instituto de Economia, Universidade Federal de Rio de Janeiro. IPEA: Institute of Applied Economic Research/Instituto de Pesquisa Econômica Aplicada. FUNCEX: Foreign Trade Studies Center Foundation/Fundação Centro de Estudos do Comércio Exterior. PARAGUAY CADEP: Center for Analysis and Diffusion of the Paraguayan Economy/Centro de Análisis y Difusión de Economía Paraguaya. Instituto Desarrollo: Development Institute/Desarrollo, Participación y Ciudadanía. URUGUAY CINVE: Center for Economic Research/Centro de Investigaciones Económicas. DECON FCS, UdelaR: Department of Economics, Faculty of Social Sciences, University of the Republic/Departamento de Economía, Facultad de Ciencias Sociales, Universidad de la República. IECON CCEE, UdelaR: Institute of Economics, Faculty of Economics and Management, University of the Republic/Instituto de Economía, Facultad de Ciencias Económicas y de Administración. 4

5 TITLES OF RED SUR PUBLICATIONS> El Boom de Inversión Extranjera Directa en el Mercosur Coordinación de Políticas Macroeconómicas en el Mercosur Sobre el Beneficio de la Integración Plena en el Mercosur El desafío de integrarse para crecer: Balance y perspectivas del Mercosur en su primera década Hacia una política comercial común del Mercosur Fundamentos para la cooperación macroeconómica en el Mercosur El desarrollo industrial del Mercosur 15 años de Mercosur Mercosur: Integración y profundización de los mercados financieros La industria automotriz en el Mercosur Crecimiento económico, instituciones, política comercial y defensa de la competencia en el Mercosur Asimetrías en el Mercosur: Impedimento para el crecimiento? Diagnóstico de Crecimiento para el Mercosur: La Dimensión Regional y la Competitividad Ganancias Potenciales en el Comercio de Servicios en el Mercosur: Telecomunicaciones y Bancos La Industria de Biocombustibles en el Mercosur Espacio Fiscal para el Crecimiento en el Mercosur La exportación de servicios en América Latina: Los casos de Argentina, Brasil y México Los impactos de la crisis internacional en América Latina: Hay margen para el diseño de políticas regionales? La inserción de América Latina en las cadenas globales de valor El impacto de China en América Latina: Comercio e Inversiones Los desafíos de la integración y los bienes públicos regionales: Cooperación macroeconómica y productiva en el Mercosur Enrique V. Iglesias. Intuición y ética en la construcción de futuro Los recursos naturales como palanca del desarrollo en América del Sur: ficción o realidad? Los recursos naturales en la era de China: una oportunidad para América Latina? Emprendimientos en América del Sur?: La clave es el (eco)sistema Uruguay + 25 Documentos de Investigación Reporte Anual y Resumen Ejecutivo Recursos Naturales y Desarrollo > Edición 2014 Integración financiera y cooperación regional en América del Sur después de la bonanza de los recursos naturales. Balance y perspectivas Natural Resources and Development Report > Edition Natural Resources and Development Report > Edition

6 1. Introduction Extractive industries should not be viewed as isolated enclaves engaged solely in primary activity, but can be real drivers of economic development with substantial potential for creating knowledge intensive industries. Since natural resources are finite, resource rich developing countries should take advantage of the opportunities created by extractive industries. Empirical evidence suggests that the reliance on natural resources can foster economic growth and development when underpinned by efforts to increase technological innovation and accumulate capabilities to innovate around natural resources (Aslesen and Isaksen, 2010; Engen, 2009; and Noreng, 2005). Moreover, traditionally vertically integrated value chains in the extractive sector have been redesigned and new production paths created through the large scale use of Information and Communications Technology (ICT) and outsourcing and subcontracting, which have led to the mushrooming of Knowledge Intensive Business Services (KIBS) firms. Globally the share of knowledge intensive services to total output has been steadily increasing over time (Stehrer et al., 2012) and KIBS firms are likely to be one of the main engines for future growth (Gotsch et al., 2011). These KIBS firms serve the demands of exploration and production and mining companies may potentially encourage structural change and diversification into a knowledge intensive industry since they may act as facilitators, sources and carriers of knowledge and innovation within the extractive sector and other sectors, as well as the country s National Science Technology Innovation (STI) system. KIBS firms therefore provide new opportunities for natural resource based developing countries to transition and diversify from extractive to knowledge intensive industries. Latin America and the Caribbean is one of the most natural resource abundant regions internationally and remains underdeveloped. Moreover, there exists little empirical evidence on the role and impact of KIBS firms in knowledge transfer, innovation and diversification, human capital development and environmental protection in the region. This paper is a step forward in filling this gap by empirically studying KIBS firms in Trinidad and Tobago s oil and gas sector. Trinidad and Tobago is rich in oil and gas resources with a well-developed downstream petrochemical industry and is the most industrialized economy in the English-speaking Caribbean (Atarna et al., 2007). The country has successfully developed a first-class oil and gas and downstream petrochemical industry which is over 100 years old and has a growing number of oil and gas KIBS firms which operate in various Caribbean and Latin American countries and even internationally in Canada, the US and Africa. The reliance on oil and gas has long been the country s strength and weakness. The United Nations Office of the High Representative classifies the country as a Small Island Developing State (SIDS) for the Least Developed Countries, Landlocked Developing Countries and the Small Island Developing States (UN-OHRLLS). It however has a relatively high GDP per capita of US$ 14,200 (constant 2005) and is also a high-income country according to the World Bank World Development Indicators (WDI). While the country has been able to diversify and add value within its oil and gas sector with a highly developed downstream petrochemical industry, it has not been able to develop viable clusters outside of the sector. Nevertheless, 6

7 the country s growth and development has been led by the oil and gas sector, which accounts for more than 45% of GDP, 48% of government revenue and 80% of exports (CBTT, 2015). However, given its capital intensive nature the sector makes up only 3% of the country s employment (CBTT, 2015). On the other hand, the oil and gas services sector where KIBS firms operate has been growing and its contribution to GDP has increased, although slightly from 4% to 5% from 2001 to 2012 (CBTT, 2013) and employs about one third of all oil and gas sector workers (The Energy Chamber of Trinidad and Tobago, 2009). Recently, there has been a drastic fall in international oil and gas prices along with falling oil and gas production locally and Trinidad and Tobago s GDP growth rate has averaged negative 0.53% in the past 5 years (WDI, 2015). There is a general agreement among policy makers, academics and the wider public that economic diversification along with improvements in innovation and productivity are critical for achieving sustainable long run growth and development. Moreover, while the government has stated its intention to diversify the economy and increase innovation expressed in various national development plans such as Vision 2020 and the Medium Term Policy Framework , there has been little success. Trinidad and Tobago s oil and gas KIBS firms may play a major role here and therefore constitute a very interesting study for the analysis of the future of extractive industries in Latin America and the Caribbean. The objective of this study is to empirically examine the role of Trinidad and Tobago oil and gas KIBS firms in diversifying the economy away from an extractive to a knowledge intensive sector. These firms may potentially act as facilitators, sources and carriers of explicit and tacit knowledge and organizational and technological innovation locally and internationally in the oil and gas sector, other sectors and more broadly in the country s national STI system. The paper also examines the role of oil and gas KIBS firms in building employment capabilities and human capital development and environmental protection and sustainability given their importance in knowledge-based economies. The paper uses primary and secondary data sources and firm specific case studies. It identifies opportunities for cooperation, knowledge sharing and successful experiences and lessons learnt from Trinidad and Tobago that can be replicated in the region. Lastly, the paper concludes by making policy recommendations, identifying opportunities and obstacles for their implementation and possible institutional implications to further develop the sector by using examples of successful policies and strategies in other countries. The paper consists of 9 sections including the introduction. The rest of the paper is organized as follows. Section 2 provides a literature review on the knowledge based economy and knowledge sharing and innovation in KIBS firms. Section 3 gives details of the methodology and various data sources used by the study. Section 4 presents an overview and economic contribution of Trinidad and Tobago s oil and gas industry as well as its oil and gas KIBS firms. Section 5 details the empirical findings on knowledge sharing, innovation, productivity and diversification of Trinidad and Tobago s oil and gas KIBS firms. Section 6 provides information on employment capabilities and human resource development by the oil and gas sector and its KIBS firms. Section 7 gives information on the oil and gas sector and the role of KIBS firms in environmental sustainability. Section 8 presents the lessons learnt from Trinidad and Tobago s oil and gas sector and makes policy recommendations. Section 9 concludes the paper. 7

8 2. Literature A knowledge-based economy is one in which knowledge is increasingly present in all aspects of economic activity and knowledge drives productivity, economic growth and sustainable development. In the literature, new growth theory attempts to directly incorporate knowledge and technology through investments, for example in ICT, research and development (R&D) and education and training, in understanding their role in driving productivity and growth. Also, equally important is knowledge distribution through ICT and formal and informal networks. Innovation arises from the interaction of producers and users of knowledge, which may be enhanced in a knowledge-based economy. The national STI system is the structure by which information flows among firms, government and academia in the development of science and technology in a country and therefore plays a crucial role in a knowledge-based economy. Further, in a knowledgebased economy there is an increased demand for highly skilled workers, which requires government policy and firms to target increased employment capabilities and human resource development. Lastly, given the rise of ICT and other technologies, a knowledgebased economy may be better able to monitor and dispose of harmful environmental emissions and other environmental impacts. A knowledge-based economy may therefore lead to better environmental protection and sustainability. The current literature offers no established theoretical framework on KIBS firms and their role in a knowledge-based economy. Nevertheless, KIBS firms are considered to be among the most innovative within the services sector with a performance comparable to hightech manufacturing activities (Nählinder, 2002). KIBS firms can be viewed as knowledge creating entities, which can help with knowledge transfer and consequently innovation, productivity and diversification. KIBS firms provide services and business operations, which are heavily reliant on professional knowledge and depend on knowledge related to specific technical fields. They provide intermediate products and services that are knowledge based and knowledge intensive support for the business operations of other companies. KIBS firms can provide scientific and technological knowledge including ICT, R&D and engineering as well as traditional professional services such as advertising, procurement, legal, accounting, management, consulting and marketing. These KIBS companies may therefore provide an avenue for the creation of a knowledge intensive economy. Knowledge is divided into two types: explicit and tacit (Nonaka et al., 1995). Explicit knowledge is codified knowledge that is readily available through written or verbal means and easily transferred. On the other hand, tacit knowledge is non-codified knowledge, is often acquired through experience and is not readily available and easily transferrable. Neo-Schumpeterian and evolutionary economics view innovation as an evolutionary process based on knowledge. Knowledge creation and transfer from the interactions between different economic agents lead to innovation and KIBS firms may play a key role here. Nonaka (1994), Nonaka and Takeuchi (1995) and Nonaka et al. (2000) state that knowledge transformation processes can occur within firms and developed a knowledge creation function to illustrate the knowledge creation capabilities of these firms. They showed that the knowledge conversion process involves both explicit and 8

9 tacit knowledge. Since knowledge generation and transfer are considered a pre-requisite for successful innovation, innovative activity is related to the generation and transfer of explicit and tacit knowledge. Consequently innovation can be understood as a cycle involving interactions between explicit and tacit knowledge. In the limited but emerging literature, KIBS firms act as facilitators, carriers and sources of knowledge for client firms (Fischer, 2001, and Hipp, 2000). KIBS companies combine highly specialized explicit and tacit knowledge in order to develop problem-specific solutions and transfer knowledge to their clients, therefore increasing the exchange of otherwise disconnected pockets of knowledge in the national STI system (Windrum and Tomlinson, 1999). Knowledge is generated, diffused and created through the interaction between KIBS firms and their clients. Also, the solutions to specific problems facing client firms can lead to the development of new knowledge (den Hertog, 2002). Further, KIBS firms play an intermediary role in transforming scientific and technical information into tacit knowledge by creating innovative solutions to meet customers needs. Additionally, it is argued that KIBS firms not only transfer knowledge to clients, but also engage in collaborative learning and can transform clients into learning organizations (Aslesen and Isaksen, 2010). KIBS firms also act as facilitators, carriers and sources of innovation as they seek to find innovative solutions to suit their clients needs and play an important role in the innovation process of client firms (den Hertog, 2000; Tether, 2005; Camacho and Rodriguez, 2008; and Naranjo-Valencia et al., 2011) and are described in the literature as bridges to innovation (Czarnitzki and Spielkamp, 2000). They provide specific and localised solutions to meet the requirements of and solve technological and organizational problems of their customers. They may assist with client innovation by suggesting that they adopt solutions previously developed by other firms or in other sectors. Hence, KIBS companies pool together various types of specialized knowledge to develop problemspecific solutions for their clients, thereby increasing innovation (Miles, 2008). KIBS firms are facilitators of innovations if they support a client in its innovation process, but the innovation does not originate from KIBS firms, nor is it transferred (from other firms) by this KIBS firm to the client firm. They are carriers of innovation if they play a role in transferring existing innovations from one firm or industry to the client firm or industry, even though the innovation does not originate from the KIBS firms. KIBS firms are a source of innovation if they play a major role in initiating and developing innovations in client firms, usually in close interaction with the client firm. KIBS firms play a critical role in contributing to a country s national STI system by providing technological knowledge diffusion and innovation within the extractive sector and throughout the economy. KIBS firms cooperate with their clients, disseminate and absorb knowledge from numerous sources, process it and pass it on in the most appropriate way to suit their clients needs. They act as an interface between their clients and knowledge generators such as universities and public and private research institutions and the knowledge base of the entire economy, and may act as a catalyst for countrywide knowledge diffusion and innovation (Castellacci, 2008, and Castaldi, 2009). Hertog and Bilderbeek (1998) view KIBS firms as a type of second knowledge infrastructure which complement and fuse with universities, think tanks and public research institutions that 9

10 make up the first or traditional knowledge infrastructure. KIBS firms may therefore act as linkage institutions in the national STI system. The impact of KIBS companies on knowledge provision and transfer and innovation will depend on the type and intensity of the relationship between the firms that provide the service, users of the service and the national STI system (Muller and Zenker, 2001; and Mas-Verdu, 2007). Hertog and Bilderbeek (1998) conducted an empirical study to investigate the role played by KIBS in the national STI system in the Netherlands. The results show the relevant role of KIBS firms in the Dutch innovation system in aspects like R&D cooperation and use as information sources, at the same level as the public knowledge infrastructure. Tether (2005) in a study of KIBS firms and the national STI system in Britain found that neither KIBS firms nor the public research infrastructure have great importance in terms of participation in formal networks for innovation and in their use as information sources for innovation. However, KIBS companies play a slightly more active role in the national STI system than the public infrastructure for formal and informal networks. There is limited but growing empirical evidence which suggests that natural resources can foster economic growth and development when accompanied by an increase in technological innovation and accumulation of capabilities to innovate around natural resources, and KIBS firms may play a key role here (Engen, 2009, and Noreng, 2005). In the extractive sector, the development and widespread use of ICT has allowed for traditionally vertically integrated global value chains to be reconfigured and new production paths established based on outsourcing and subcontracting. The demandpull, together with changes in the production function, has induced the rise of KIBS firms that serve the special demands of large natural resource based companies. In developed, natural resource endowed countries, such as Finland, Norway, Canada and Australia, these KIBS firms satisfy a growing demand for knowledge, new technology and innovation in the extractive sector and serve as providers of solutions for technological and organizational problems. They play a critical role in knowledge transfer, innovation and technology diffusion across the extractive sector, other sectors and the national STI system and diversification towards related higher value added goods and services and ensure that forward, backward and horizontal linkages are created with the rest of the economy. Market failures may hinder the development of KIBS firms in the extractive sector, especially in developing countries, given the complexity and tacitness of knowledge. Innovation requires intense interaction and cooperation between the users (the natural resource firms) and the knowledge providers (the KIBS firms). In this interaction, asymmetric information problems may emerge affecting the matchmaking process and then hindering investment decisions (moral hazard and hold-up). The situation becomes more complex if spillovers are present and the intangible nature of the transaction makes contracting very difficult. Finland, Norway, Canada and Australia have established specific programs to tackle these market failures while such programs are limited in natural resource based developing countries like Latin America and the Caribbean. 10

11 3. Methodology and data sources To explore the role of oil and gas KIBS firms in diversifying the economy away from an extractive to a knowledge intensive sector, the study uses a simple conceptual framework. It analizes the national STI system and several aspects of oil and gas KIBS firms: information sources for innovation, innovation collaboration, innovation activity, product and process innovation; diversification; employment capabilities and human resource development; environment and sustainability. KIBS firms are analyzed as facilitators, sources and carriers of explicit and tacit knowledge and product and process innovation locally and internationally in the oil and gas sector, other sectors and the national STI system. Sources of information used for innovation, innovation activities and innovation collaboration are divided into four categories: internal sources (from within the firm or enterprise group); market sources (customers, suppliers of equipment, materials, components and software, consultants, commercial labs and private R&D institutes, competitors and other market sources); public sector sources (universities/other higher education institutions and government/public research institutes); and other external sources (scientific journal and trade/technical publications, conferences, trade fairs and exhibitions, and professional and industry associations). The study uses primary and secondary data sources, and case studies. The secondary data used comes from several sources. Firstly, the Energy Chamber of Trinidad and Tobago conducts a quarterly Energy Services Sector Survey of oil and gas service firms in Trinidad and Tobago, which maps their performance and optimism and provides data on business confidence, plans for investment and expansion, employment and training. The Energy Chamber also has a comprehensive listing of firms operating in the oil and gas services sector and their respective market segments in Trinidad and Tobago. General firm information on the year the firm was established, the type of ownership, whether it is export or non-export oriented, the partnerships it has developed, the technology used, and products offered are taken from the websites of various oil and gas service firms. The paper uses data on the number of on-shore and offshore rigs in use from the Ministry of Energy and Energy Affairs Monthly Consolidated Bulletins as well as information from Trinidad and Tobago s Heritage and Stabilization Fund Reports. General macroeconomic such as GDP, government revenue, exports, employment, oil and gas production and value added are taken form the Central Bank of Trinidad and Tobago. The paper also uses secondary data from various government reports and policy documents. Primary data are collected through a questionnaire with key industry stakeholders. The questionnaire is displayed in the appendix. Lastly, to deepen the analysis the paper also uses various case studies. 11

12 4. Trinidad and Tobago s oil and gas industry 4.1. Overview Trinidad and Tobago s oil and gas industry is over 100 years old and is one of the oldest in the world. The country is the largest oil and gas producer in the Caribbean. It has undertaken extensive exploration activity on-shore and offshore and has a cumulative oil production totaling over 3 billion barrels and has estimated proven oil reserves of 728 million barrels. 1 While Trinidad and Tobago s hydrocarbon sector started off as being oil dominated, by the late 1970s and early 1980s the industry profile was changing from a focus on oil to gas, which then led to the development of the petrochemical sector. During the late 1960s to early 1970s, significant oil discoveries were made off the southeast coast of Trinidad. Oil production then peaked, stimulating further exploration activity, which led to significant natural gas discoveries. Furthermore, the creation of Atlantic LNG in the 1990s for the production and export of LNG further increased the importance of Trinidad and Tobago s gas sector. The country has a well-developed upstream, midstream and downstream oil and gas sector with KIBS firms operating throughout the value chain. The upstream sector consists of large exploration and production companies, such as bp Trinidad and Tobago, BHP Billiton and the Petroleum Company of Trinidad and Tobago (Petrotrin), together with smaller companies like Venture Trinidad. Petrotrin, which is state owned, is the only company for refining. The midstream sector also has a single player which is state owned, the National Gas Company of Trinidad and Tobago (NGC). National Petroleum (NP) and the United Independent Petroleum Marketing Company Limited (Unipet) operate in the downstream sector and market and distribute petroleum products. Additionally, the downstream petrochemical sector consists of 11 ammonia plants, 7 methanol plants, 1 urea plant, 1 Natural Gas Liquids Processing Facility, 4 Liquefied Natural Gas (LNG) Trains and 1 Ammonia Urea Ammonium Nitrate Melamine Complex. Moreover, the government has plans to further diversify the downstream sector and the Ministry of Energy and Energy Affairs has been in talks with investors for the manufacture of calcium chloride and dimethyl ether. The country s natural gas processing facility is one of the largest in the Western Hemisphere the Phoenix Park Gas Processors Limited (PPGPL) with a processing capacity of almost 2 billion cubic feet per day and an output capacity of 70,000 barrels per day of natural gas liquids (NGL). After processing, the gas is transferred to the various power generation sites for electricity generation and to the various petrochemical plants for use as a feedstock. The electricity sector is fueled entirely by natural gas. Output from the downstream sector is targeted mainly for export. Foreign private capital played an important role in the development of the petrochemical sector as part of a deliberate government strategy, because of the large capital required and access to international markets. 2 The government also entered into a number of joint venture arrangements with varying levels of participation

13 Currently, international oil and gas prices are low, most of the country s oil fields are mature and depleted, and local production is on a decline. A number of bid rounds are being carried out in an attempt to increase deep-water exploration. The situation presents numerous opportunities for innovation and diversification in Trinidad and Tobago s oil and gas sector particularly around geological evaluations, seismic survey and enhanced oil recovery operations and for increasing energy services exports Economic contribution Trinidad and Tobago s oil and gas sector has contributed significantly to the country s GDP growth. Figure 1 shows that the share of GDP from the oil and gas sector increased from 28.3% in 2001 to 42.2% in The exploration and production sub-sector accounted for the largest contribution to GDP, while refining, petrochemicals and service contractors, distribution and asphalt production, which include oil and gas KIBS firms, played a relatively small role. Nevertheless, there has been some growth in the service contractors, distribution and asphalt production sector from 4% to 5.5% for More recently, in the period the oil and gas sector experienced a four year decline in real output. This was mainly because of falling international oil and gas prices along with production stoppages at two large natural gas producers, and a decline in real output in the refining sub-sector because of maintenance work and lower refinery throughput at Petrotrin (CBTT, 2014, Annual Economic Outlook). This consequently resulted in weaker overall GDP growth of negative 1%, despite steady positive growth in the non-energy sector, highlighting the major influence the oil and gas sector has on the overall economy (CBTT, 2014, Annual Economic Outlook). Figure #1: Economic contribution of the oil and gas sector, share of GDP (%) % of GDP Year Oil and Gas Sector (Total) Refining (including LNG) Service contractors, distribution and asphalt production Exploration and Production Petrochemicals Source: Central Bank of Trinidad and Tobago. 13

14 During the four-year decline, however, the service contractors, distribution and asphalt production sector experienced its highest contribution to GDP, of 6.1% since This may have resulted from the increased maintenance work of the refining sub-sector. During periods of falling oil and gas prices, exploration and production activity may decrease, and firms may take the opportunity for planned maintenance and shutdown, which may translate into increased activity in the oil and gas services sector for rig and plant maintenance and inspection services thereby benefiting KIBS firms which offer these services. One of the most significant and direct links of Trinidad and Tobago s oil and gas sector to the entire economy is through government revenue, since oil and gas revenues are the largest annual contributors, through taxes and profits from state owned enterprises and joint ventures, and royalties and payments under contractual arrangements, like concessions and production sharing agreements. Figure 2 shows the share of government revenue from the entire oil and gas sector, as well as broken down into exploration and production taxes (refining and gas processing, petrochemicals and service contractors) and other taxes (withholding tax, royalties oil impost, unemployment levy, excise duties and receipts from signature bonuses for the award of production sharing contracts). Since 2001 the share of government revenue from the oil and gas sector has increased from 32.8% to 48.1%, reaching as high as 61.95% in 2006, when oil prices were very high. Exploration and production taxes have been increasing since 2001 until 2010, after which they began to decrease and were offset by an increase in other taxes. Since 2011, international oil and gas prices and local production have been falling and government revenue has been on a continuous decline. Government revenue from the oil and gas sector in Trinidad and Tobago is used to fund human capital investments in education, health and security, to make work programs, for infrastructural development and to support the development of other sectors. Trinidad and Tobago has also created a sovereign wealth fund the Heritage and Stabilization Fund in 2007 to help insulate the economy from oil and gas price fluctuations. An Act of Parliament, the Heritage and Stabilization Fund Act, 2007, established the Fund. The Act states that the purpose of the Fund is to save and invest surplus oil and gas revenues to: 1) cushion the impact or sustain government expenditure during periods of revenue decline because of falling international oil and gas prices; 2) generate an alternate stream of income to support government expenditure because of a fall in revenue caused by the depletion of non-renewable oil and gas resources; and 3) provide a heritage for future generations of Trinidad and Tobago from savings and investment income derived from excess oil and gas revenues. Deposits into the Fund are made when oil and gas revenues exceed expectations. Table 1 shows the valuation of the Fund and contributions since it was set up in The data are taken from the Heritage and Stabilization Fund Quarterly Reports from the Ministry of Energy and Energy Affairs. As seen in the table, while the valuation of the Fund has been steadily increasing, contributions are highly variable since it is dependent on government revenue, which is influenced by the international oil and gas price and local production. The recent fall in oil and gas prices along with declining production has had a negative and destabilizing effect on Trinidad and Tobago s fiscal budget. The government had to revise its national budget figures and plan to reduce expenditure by 7% across all ministries and state owned enterprises. The government also used funds from the Heritage and Stabilization fund to make up the shortfall in revenue. 14

15 Figure #2: Economic contribution of the oil and gas sector, share of government revenue (%) % of Government Revenue Year Oil and Gas Sector (Total) Other taxes Exploration and Production Source: Central Bank of Trinidad and Tobago. Table #1: Heritage and Stabilization Fund valuation and contributions Year Valuation US million Contributions US million Source: Ministry of Energy and Energy Affairs. Trinidad and Tobago s oil and gas industry contributes tremendously to exports. Figure 3 shows that the share of the oil and gas sector to the country s total merchandise exports has been increasing from 2001 to 2014, from 78.2% to 85%, with a high of 91.1% in 2006, given the high oil and gas prices at the time. Additionally, Table 4 shows that within this period exports have remained constant since the fall in international oil and gas prices and local production from The table also shows oil and gas exports broken down by extracted exports (crude oil); refined exports (petroleum, liquefied natural gas and natural gas liquids); and processed exports (all other oil and gas related exports such as petrochemicals). Refined exports make up the largest contribution of oil and gas merchandise exports, followed by processed exports and then petrochemical exports. Figure 3 also shows that the contribution of all three sub-sectors has been increasing since 2001; although from 2011 extracted exports have remained constant, and refined and processed exports have fallen. Data on energy services exports is not available. The Energy Chamber of Trinidad and 15

16 Tobago, however, approximates that there are local companies which export energy services regionally and internationally (Trinidad and Tobago Energy Chamber, 2009). Figure #3: Economic contribution of the oil and gas sector, share of merchandise export receipt (%) % of Exports Year Oil and Gas Sector (Total) Refined Extracted Processed Source: Central Bank of Trinidad and Tobago. Trinidad and Tobago s oil and gas sector contributes little to direct employment since the sector is generally capital intensive with limited opportunities for permanent employment. Figure 4 shows that the average employment in the oil and gas sector is about 3.5% of total persons employed. Since 2011 employment in the sector has remained constant at 3.3%. The capital-intensive nature of the oil and gas sector is unlikely to change in the future. Hence, the country s main economic sector is not its main employer. Nevertheless, while the oil and gas sector only accounts for around 3.5% of total employment, the oil and gas services sector is said to be a major employer within the oil and gas sector and the Energy Chamber of Trinidad and Tobago estimates that it employs about one third of all oil and gas sector workers (The Energy Chamber of Trinidad and Tobago, 2009). Also, the majority of workers in the oil and gas services sector are highly skilled nationals of Trinidad and Tobago, working in both local and foreign companies (The Energy Chamber of Trinidad and Tobago, 2009). Data on employment in the oil and gas services sector is not available. 16

17 Figure #4: Employment Total persons employed (000 s) % Employed in oil and gas Year Total persons employed (000 s) % Employed in oil and gas Source: Central Bank of Trinidad and Tobago. As seen above, the oil and gas industry in Trinidad and Tobago makes important contributions to GDP, government revenue and exports. Figure 5 shows the relationship among these variables. The solid line represents real GDP growth and the dotted line shows real GDP growth by the oil and gas sector, while the dark bars show oil and gas government revenue as a percent of total government revenue and the light bars show oil and gas exports as a percent of total exports. The country s overall GDP growth is heavily influenced by growth in the oil and gas sector. As seen in Figure 5, the country s real GDP growth closely follows GDP growth in the oil and gas sector. Moreover, since 2006 real GDP growth and GDP growth in the oil and gas sector has been declining. The figure also illustrates that when growth in the oil and gas sector is high, the share of government revenue and exports from oil and gas increases, while a low growth rate is associated with low revenue and exports and since 2006 both have been declining. The figure therefore suggests that the oil and gas sector plays an important role in the national economy and what happens in the oil and gas sector may affect other aspects of the economy. 17

18 Figure #5: GDP growth, government revenue and exports Revenues and exports GDP growth Year Oil and gas revenues/total revenues GDP growth Oil and gas exports/total exports GDP growth, oil and gas sector Source: Central Bank of Trinidad and Tobago Trinidad and Tobago oil and gas KIBS firms Trinidad and Tobago s oil and gas KIBS firms offer technical services to the oil and gas sector, locally, regionally and internationally, along the entire oil and gas value chain. Exploration and production companies do not typically complete all the tasks in the oil and gas value chain themselves since they are difficult and costly and involve the use of highly specialized knowledge, skills, equipment and technology. On other hand, oil and gas KIBS firms offer technical and professional services and provide specialized equipment to exploration and production companies, but do not typically engage in the production of oil and gas. These services aim to improve operational efficiency and minimize the risk of oil and gas exploration of production companies, thereby saving them time and money. Trinidad and Tobago oil and gas KIBS firms may therefore act as facilitators, carriers and sources of knowledge and innovation along the entire oil and gas value chain and engage in local, regional and international knowledge spillovers. While Trinidad and Tobago s oil and gas industry is over 100 years old and always required energy services, in 1989 the government first introduced the lease operatorship and farm out program. The aim was for oil and gas services to be contracted out to local firms thereby reducing the operating cost of exploration and production companies and making uneconomic wells and blocks economic once more. This led to a mushrooming of local oil and gas KIBS firms. Trinidad and Tobago, in further developing its oil and gas services sector in 2004, implemented the Local Content Strategy for the Energy Sector, where local content includes ownership, control, decision making and preferential access to finance by citizens 18

19 of the country. The local content strategy focused on: 1) local capability development (international exploration and production companies are required to contract local service providers so that they are given the opportunity to work, learn and acquire knowledge); 2) education and training (support to universities, establishment of specialized learning and training centres and the design of appropriate academic curricula); and 3) diversification and new business creation (to develop the capacity to supply local industry needs and create new export opportunities). Moreover, according to the local content policy, oil and gas exploration and production companies should give preference to local KIBS firms that are qualified and meet quality, cost and schedule requirements and should monitor local content and the cost of local materials, labor and services. Production sharing contracts should also include requirements for local content to match the capability of local KIBS firms and to ensure that seismic activity is undertaken locally and that there is transfer of technology and expertise. While Trinidad and Tobago s local content policy has played a useful role in the development of domestic KIBS firms, there are several shortcomings of the policy, which if addressed may allow for further development of these local firms. There is currently no institution responsible for the coordination and implementation of the local content policy and to ensure compliance. The setting up of a Permanent Local Content Committee was proposed but never implemented. Additionally, the government planned to establish a database on the status of projects and opportunities to help oil and gas exploration and production companies find local KIBS firms but this has not taken place. The local content policy also lacks the legislative provisions to ensure compliance and dedicated resources to monitor implementation and measure targets (Tomas et al., 2012). In 2004 the government also proposed the establishment of the Centre for Energy Enterprise Development (CEED) to increase local participation in value added oil and gas projects, increase the depth and scope of the local industry, develop business skills and competencies in small and medium enterprises (SMEs), boost innovation and new thinking, help entrepreneurs enter niche markets and the creation and support of clusters with other industries that have natural synergies with the oil and gas sector to increase diversification. However, a Centre for Enterprise Development (CED) was eventually launched, which is not limited to the oil and gas sector only, but instead focuses on building capacity and capability for enterprise creation from idea to market in all sectors. As such it provides accommodation and technical and business advisory support services to persons or firms with innovative ideas wishing to take these through from incubation to commercialization. This may hinder oil and gas KIBS firms from achieving their full potential given the lack of support tailored to meet the needs of the industry. Trinidad and Tobago oil and gas services sector consists of approximately KIBS firms (The Energy Chamber of Trinidad and Tobago, 2009). These firms are well established, are mainly SMEs and are privately owned family run companies, although some are subsidiaries of major conglomerates. There are also large multinational corporations operating in Trinidad and Tobago including Baker Hughes, Schlumberger, Halliburton and Weatherford. Local oil and gas KIBS firms initially competed against these international firms without any trade barriers, however in 2004 government support came about with the development of the local content policy. The initial exposure to competition followed by government 19